Monday, August 1, 2016

A Modest Proposal to End Fed Independence

A Modest Proposal to End Fed Independence

During the period 1980s and
1990s, the desirability of the “independence from politics” of central
banks became almost an article of faith among mainstream macroeconomists
and those operating in financial markets. This development was driven
by two factors: academic research on central banking; and the
personality cults that grew up around the two Fed Chairmen during this
period, Paul Volcker and Alan Greenspan.
In the decade leading up
to the financial crisis, the intellectual climate was such that anyone
suggesting that the Fed have its independence curtailed or even
abrogated by Congress would have been considered beyond the pale of
rational, let alone scholarly, discussion. However, as the painful and
protracted recovery from the Great Recession has dragged on, the Fed’s
independence of “politics,” i.e., of legislative oversight and
constraint, has begun to be challenged even by economists and financial
pundits.

Few of the recent proposals to curb the Fed’s
independence mentioned envision fundamental institutional reform of the
way in which base money is supplied under our current fiat-dollar
regime.
One such reform would involve wresting control of the
money supply away from the unelected technocrats at the Fed and
returning it to Congress and the Treasury. In fact this reform was put
forward during the controversy over raising the debt ceiling in 2013.
It
is important to note that this blueprint for monetary reform closely
approximates — in its fundamentals if not in its aim or sophistication —
the monetary and fiscal framework that Milton Friedman proposed in
1948. The monetary component of the proposal focused on eliminating
“both the private creation or destruction of money and the discretionary
control of the quantity of money by central-bank authority.” The first
goal would be attained by implementing Henry Simon’s “Chicago Plan” for
100 percent reserve banking. Friedman maintained that the second
objective could be achieved by eliminating the issue of interest-bearing
government securities to the public, thereby restricting the financing
of government spending to taxation and money creation. Thus, as Friedman
pointed out: “Deficits or surpluses in the government budget would be
reflected dollar for dollar in changes in the quantity of money; and,
conversely, the quantity of money would change only as a result of
deficits or surpluses.”
A common objection to such a proposal is
that if money were under the control of the Treasury, monetary policy
would become a political football and inflation would run rampant. But
how much more inflationary would monetary policy become than it is right
now? The unaccountable bureaucrats at the Fed have fastened on the US
economy a regime of zero interest rates, quantitative easing, and the
targeting of a real variable (the unemployment rate) using nominal
variables. The latter is a reversion to stone-age Keynesianism. Indeed,
current Fed policy has enabled a fiscal policy of high deficits and
rapidly mounting national debt, anyway.

An Austrian View of Money, Taxation, and Spending

Let
us grant for the sake of argument that congressional control of
monetary policy alters the mix of financing government spending toward
less taxation and more deficits financed by money creation. From the
point of view of Austrian public finance theory, the method of governmental “revenue extraction” does not matter nearly as much as the total amount extracted.
For all government spending drains resources from productive uses in
the private economy and squanders them on the wasteful spending of
politicians and bureaucrats on their favored projects and
constituencies. Government spending is either consumption spending that
directly satisfies the preferences of members of the political
establishment or it is investment in waste assets because it is not
based on the profit and capital-value calculations that guide the
decisions of private entrepreneurs and capitalists. It is in effect a
redistribution of income and resources from the productive to the
unproductive, from the “taxpayers” to the “tax-consumers.”
The
total amount of government spending is therefore what Murray Rothbard
called “government depredation on the private product.” For Austrian
economists, then, the method of financing government depredation —
whether it be taxation, borrowing from the public, or money creation —
is of secondary importance. Thus, at a given level of government spending,
siphoning off resources from the private economy via deficits financed
by money creation is no worse than extracting them through taxation.
Indeed inflationary finance may even be preferable to taxation because
the threat of physical coercion implicit in taxation has a detrimental
effect on the direct utility of private individuals that goes beyond the
expropriation of their income.
Needless to say, from the point of
view of consumer welfare and economic efficiency, a smaller government
budget financed by money creation is preferable to a larger budget that
is in balance. Obviously, legislative control of the fiat money supply
is far from the ideal monetary system, and my sole purpose here is to
suggest a politically feasible solution to the urgent problem of
arbitrary power exercised by a clique of Federal bureaucrats.
The
desideratum of the Austrian political economist with classical-liberal
or libertarian leanings involves the complete separation of government
and money through the establishment of a commodity money like gold (or
silver), the supply of which is determined exclusively by market forces.
Nonetheless, there is great merit in replacing the opaque and
pseudo-scientific control of “the money supply process” by entrenched
Fed employees and officials with overtly political control of money by
elected officials and partisan administration appointees. There are a
number of benefits of stripping the Fed of its quasi-independent status
and transforming it into a handmaiden of the Treasury, as the American
Monetary Institute (AMI) and early Friedmanite reform programs call for.

How It Would Work

First,
money would be created in a transparent manner that is understandable
to the public at large. The Treasury would simply send an administrative
order to the Fed to credit its checking account with the sum of money
needed to pay the government’s bills that are not covered by tax
revenues. Now, formally, this order may be called a “Treasury bond,” but
it would not be a bond in the economic sense because it would not be
exchanged in financial markets. Nor would the “interest” that the
Treasury may pay on these pseudo-bonds really be interest because it
would not be determined by supply and demand on financial markets.
Rather it would be a payment to reimburse the administrative costs of
the Fed and its amount would be completely controlled by the Treasury.
It thus becomes evident to the public that every increase in the money
supply engineered by the Treasury benefits the specific individuals
and firms receiving government checks. The new money is being created
from nothing to purchase military aircraft from Boeing, to subsidize
agribusiness giant Monsanto, to bail out General Motors, etc.
This
contrasts with the arcane process by which money is now created, which
involves the Treasury issuing debt that is purchased by private
entities, mainly banks and other financial institutions, and then
eventually repurchased by the Fed via open market operations. In this
way the Fed circuitously “monetizes the debt” and expands the money
supply while distorting interest rates in the bargain. Invisible to the
layperson is the fact that twenty or so privileged Wall Street (and
foreign) banks and financial institutions — so-called “primary dealers” —
that sell bonds to the Fed profit immensely from the money creation
process. Also benefiting from the newly created reserves are the
commercial banks’ business clients who borrow the money at reduced
interest rates and spend it to appropriate extra resources before prices
have begun to rise.
Furthermore, under this plan, the Fed would
no longer function as a discretionary lender (bailer-outer) of last
resort, a role that infects the entire financial system with pandemic
moral hazard. No longer would the Fed be able to surreptitiously,
arbitrarily, and without democratic oversight or accountability bail out
all kinds of financial institutions in the United States as well as
foreign countries. First of all there would be no need to bail out pure
depository institutions because all such institutions would hold 100
percent reserves. But, second, even if purely financial
(non-money-issuing) institutions were in danger of failing, the
decisions to bail them out would be made by an openly partisan Treasury
under the watchful eye of the congressional opposition and in full view
of the public. With the Fed neutered and unable to leap to their rescue
at the first sign of distress and with their appeals for bailouts
subject to full scrutiny by a skeptical congress and public, financial
institutions would run their affairs much more prudently.